Don't Forget About Gold but Watch the Currencies

A recent International Monetary Fund report estimates that China exports more
inflation to the developing countries than had been previously assumed. For
every 1 percentage increase in Chinese inflation, the increase in Asia-Pacific
countries is 0.25-0.5 percent. The report argues that the real danger for regional
inflation is an up-tick in Chinese output driving commodity prices up. It notes
that a 1 percent increase in Chinese output can raise global commodity price
inflation by about 5 percent and that the Asian-Pacific region is especially
vulnerable to commodity price increases since food and energy compose a sizable
proportion of average daily spending.

China's strategy to build up an enormous export-led growth engine has been
to use low wages and to keep its currency cheap. Experts estimate that the
Chinese yuan is 40% undervalued, making Chinese products artificially cheap.
China has also used its huge market to lure Western companies to transfer their
next-generation technology to China. Goods are as much "copied in China" as "made
in China." Many Chinese realize that it is time to change that template but
that will be difficult as long as China's entire system stifles creativity
by putting emphasis on rote learning rather than innovation.

The U.S. Senate has recently voted for the Currency Exchange Rate Oversight
Reform Act of 2011, which would allow the US to punish any country that manipulates
its currency with special duties and import tariffs. The bill is targeted at
China, even though it doesn't mention any country specifically. It is unlikely
that the bill will pass the House. Even if it does, it is not likely that such
a bill will persuade Beijing to change and it could ignite a trade war. It
has already provoked a strong response from China. Beijing describes it as
trade protectionism, condemning the bill as a serious violation of World Trade
Organization rules and a "ticking time-bomb" that could ignite a trade war.

America has to get used to the idea that it will never get those labor intensive
assembly jobs back. The differences in wage are too large, regardless of what
China does with the yuan.

Keep in mind that China is the world's largest holder of American debt. Or,
as "Late Night" talk show host, David Letterman, said recently: "Two things
you need to know about taxes. They've extended the deadline to April 18, and
when you write your check, just make it out to China."

http://stockcharts.com/Having said so
much about currencies, let's not delay any longer and let's turn to this week's
technical part with the analysis of currency markets. We will start with the
long-term Euro Index chart (charts courtesy by http://stockcharts.com.)

In the long-term Euro Index chart, we've seen the index level bounce off the
resistance line, move down to the support level and then pull back up to resistance.
Now it is at the declining long-term resistance line, which coincides with
the 61.8% Fibonacci retracement level (it moved only slightly higher since
we created the above chart). These two lines now coincide and this likely helped
keep the index from bigger rally this week.

If the index manages to move above the resistance level and hold for three
days, the breakout will likely lead to even higher index levels with a target
around 143. It's possible that the euro could rally even more. Clearly, the
situation is currently tense. A decline from here would confirm the breakdown
and a move higher would invalidate the breakdown. As is often the case, time
will tell all and what eventually happens will be a key determining factor
for the subsequent direction of the currency markets.

On a side note, please keep this chart in mind when you hear talk about technical
analysis being no longer valid. The recent reversal after a bullish-hammer-candlestick-pattern
coinciding precisely with the Fibonacci retracement level was no coincidence.

We look at the implications for the dollar and for the price of gold as we
compare them side-by-side (if you're reading this essay on SunhineProfits.com,
you can click the above chart to enlarge it). Here we have some food for thought
for those who claim that the correlation between gold and the dollar has disappeared
or is no longer applicable. The analogy between today and late 2009 played
out remarkably well, as a decline in the dollar coincided with an upswing in
gold's price. So where is the next move from here?

With the tense situation in the currency markets, especially with respect
to the euro, the situation is quite blurry. The Eurozone tensions have diminished
somewhat this week and a move higher for the euro appears to be about a 55-45
likelihood and would, of course, result in a likely decline in the USD Index.

If you recall what we wrote in our last essay on the bullish
outlook for gold, you will notice that the current outlook for the USD
Index confirms what we wrote then:

We are inclined to think that we're relatively close to an upswing in gold.
The point here is if a decline is seen before the upswing, it could simply
be the formation of a double bottom with the rally yet to come. So a short
move down did not invalidate any rally this week since the rally had not
yet begun. We have simply seen a rebound after an initial bottom with a second
bottom now being formed. As long as the two support levels in the $1,600
range hold, the outlook remains bullish.

Summing up, a move up in the Euro Index and a move down in the USD
Index would have bullish implications for precious metals and the above-mentioned
point is very much up-to-date. It fact, it seems that the precious metals market
is already moving higher even without waiting for a signal from currencies,
which means that if that signal comes, the rally could accelerate.

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Przemyslaw Radomski, CFA (PR) is a precious metals investor and analyst who
takes advantage of the emotionality on the markets, and invites you to do
the same.

His company, Sunshine Profits, publishes analytical software that anyone can
use in order to get an accurate and unbiased view on the current situation.

Recognizing that predicting market behavior with 100% accuracy is a problem
that may never be solved, PR has changed the world of trading and investing
by enabling individuals to get easy access to the level of analysis that
was once available only to institutions.

High quality and profitability of analytical tools available at www.SunshineProfits.com are
results of time, thorough research and testing on PR's own capital.

PR believes that the greatest potential is currently in the precious metals
sector. For that reason it is his main point of interest to help you make
the most of that potential.

As a CFA charterholder, Przemyslaw Radomski shares the highest standards for
professional excellence and ethics for the ultimate benefit of society.

Disclaimer: All essays, research and information found above represent
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